The fear of missing out, otherwise known as “FOMO”, is often a natural reaction. Whether your neighbours have bought a brand-new TV, or your friends are going on holiday, FOMO can have a serious influence on your decisions.
It’s no different when investing, either. FOMO can often lead investors to follow the herd without carrying out due diligence, or considering how their actions could affect their financial circumstances.
Historically, there have been plenty of examples of investors blindly copying others and losing out financially.
More recently, technological advancements have led to many experts suggesting that artificial intelligence (AI) could become the next investment bubble. This typically sees a rapid escalation of asset values, often driven by exuberant market behaviour, before a sudden and often sharp decrease.
So, read on to find out why acting on FOMO can often leave you out of pocket, and discover four historical examples of when investors have lost out because of herd behaviour.
Herd behaviour and investment bubbles could harm your portfolio
Investment bubbles and herd behaviour can often cause volatility in markets.
For example, if consumers follow each other by investing in a particular stock or fund and then realise they’ve made the wrong decision, they could reverse that decision and head in the opposite direction. This can increase the volatility of the market.
By simply following others, you’ll also be more likely to make investment decisions that aren’t based on facts or what is right for you. Put simply, prudent investment decisions require research and careful consideration, which can’t always be possible to find when following trends.
Moreover, any investment decisions based on following the herd will likely be irrational and made without thinking about all the pros and cons.
Below are four examples of when herd mentality created investment bubbles and cost investors dearly.
1. The popularity of tulips bloomed and then wilted
“Tulip mania” in the early 1600s in the Netherlands was one of the most significant economic bubbles in history.
A newly exotic flower and greatly admired for its beauty, tulips very quickly became a hot commodity and prices increased along with the rise in demand. At the peak of tulip mania, in February 1637, some single tulip bulbs sold for more than 10 times the annual income of a skilled artisan.
The value reached previously unheard-of heights before abruptly plummeting.
Numerous investors lost their fortunes when the tulip bubble burst, leaving them with largely worthless bulbs. This is a classic example of investors following the herd without necessarily doing due diligence and thinking about whether the investment was suitable for them.
2. Uncalculated speculation around the South Sea Company led to investors losing money
Given a monopoly on trade with South America, the South Sea Company was the focus of a speculative investment bubble in the early 1700s.
The company began by offering 6% interest to those who bought stocks. However, when the War of the Spanish Succession ended in 1713, the expected trade explosion between the UK and South America didn’t happen. With the UK only allowed a limited amount of trade, the South Sea Company was unlikely to generate the profits it needed to sustain it.
While King George taking ownership of the company in 1718 inflated the stock and saw it returning 100% interest, the company was not making anywhere near the profits it had promised investors. Instead, it was just trading in increasing amounts of its own stock.
By August 1720, the stock price had reached £1,000. Just a month later, in September, the bubble burst. Indeed, by December, the stocks had plummeted to just £124. This resulted in many investors losing all their money, and the bubble is still regarded as one of the first financial crises in modern history.
This story is a reminder of the risks of uncalculated speculation and investing in shares without considering the ramifications on your financial circumstances.
3. Social media speculation led to GameStop’s share price rising and falling quickly
Speculation by users on the social media site Reddit led to the share price of US retailer GameStop rising very quickly in a short period of time.
By speculating about potential returns and purchasing large numbers of shares in the gaming company, these social media users led to longer-term investors initiating a “short squeeze”.
As a result, this pushed the price higher. Indeed, by 28 January 2021, the share price had risen to $483, compared to just $19 a few days before.
However, when the share price inevitably fell, many people who followed the crowd – especially those who invested later – lost out.
GameStop’s rapid rise and fall highlights the importance of carrying out your own research and working with a financial planner to create an investment portfolio that’s tailored around your risk profile, rather than just following the herd.
4. Potential AI investment
With the advancements in AI comes the speculation of potential investment gains. Indeed, one of the world’s AI computing companies, Nvidia, has become the latest target for investors seeking financial opportunities.
As a result of this increasing demand, and the announcement on 29 August of a partnership between Nvidia and Google Cloud, shares have risen by more than 200% in 2023, from $143 to more than $450, Investors.com reported.
This has led to certain investment experts predicting a new investment bubble. As reported by Bloomberg, leading American investor Rob Arnott has suggested that the Nvidia stock is a “textbook story of a big market delusion” and that it’s possible any potential bubble burst could bring down the whole market.
Work with a financial planner to help you make the best decision for your circumstances
While it can be tempting to follow the herd when there’s a surge in demand for certain investments, it’s important to focus on your own goals and have a financial plan in place that takes your risk profile into account.
Working with a financial planner could help you identify how much risk you’re willing to take. They’ll also act as a sounding board for all your investment decisions, and help you understand whether investing in a particular share or fund would be right for your financial circumstances.
If you are looking to diversify your investment portfolio and want the peace of mind of knowing professionals are in your corner, speak to us. Email hello@sovereign-ifa.co.uk or call us on 01454 416653.
Please note
Investments carry risk. The value of your investments (and any income from them) can go down as well as up and you may not get back the full amount you invested. Investments should be considered over the longer term and should fit in with your overall attitude to risk and financial circumstances.
